Tax Basis for Inherited Assets

When you sell stocks, art, or other assets you’ve inherited, what is your tax basis for determining gain or loss? The rules can be confusing, especially if you inherit property in 2010.

General Rule

Usually, your basis for inherited assets is the fair market value of the assets on the date of the death of the person you inherited the assets from (he or she is called a decedent). This is referred to as a stepped-up basis because any appreciation that the decedent experienced is not taxed; you figure your gain (or loss) based on an asset’s value at the time of death. It’s still called a stepped-up basis even though the value of an asset may have declined during the decedent’s life.

For example, your aunt purchased 100 shares of X Corporation many years ago for 50¢ a share. She died in 2009 and left them to you; their value at the time of her death was $4,000. If you sell the shares now for $5,000, your gain is only $1,000 (the difference between what you receive, $5,000, and your tax basis of $4,000). If the facts were reversed and she had paid $4,000 for stock worth only $50 at the time of her death, your basis would be $50.

If an estate was large enough to have filed a federal tax return and the executor, administrator, or personal representative elected to use the “alternate valuation date,” which is 6 months after the date of death, then your basis is the value of the inherited assets on this other date.

Jointly owned property. If you inherited property because you were a joint owner and were not married to your co-owner, then your tax basis typically is the entire value of the property at the time of death (or alternate valuation date, if applicable). However, if you paid for part of the property and the co-owner’s estate took your portion into account for its valuation for estate tax purposes, then your basis is what you paid for your share, plus the value of the co-owner’s share for estate tax purposes.

For example, you and your brother together bought an antique rug that’s been in his home for years; you no longer remember or have any proof of what you paid toward the rug’s purchase price, although you remember it cost only $500. It’s worth $3,000 at your brother’s death when you inherit it. Since his estate must include the full value for tax purposes, your basis is $3,000. If the estate can show that he paid half, then your basis would be $250 (half of the original cost), plus $1,500, half of the value at the time of your brother’s death.

Special Rule for Spouses

Generally, for any assets that you jointly own with your spouse who is a U.S. citizen, half of their value becomes part of your basis; you also add what you paid, if any, toward their purchase price.

For example, you and your spouse bought a house in 1990 for $175,000; your spouse died in 2009 when the house was worth $250,000. Your basis for determining gain when you sell the home is $237,500 (half of the estate tax value of $150,000, plus half of the original cost, which is $87,500).

Special rule for joint tenancies created before 1977. If you and your spouse bought property jointly before this date and your spouse paid for the entire asset, then you get a full stepped-up basis. In the example above, if your spouse made the down payment on the home, your basis would be $250,000, 100% of the value at the time of your spouse’s death.

Special rule for community property. Since one half of the fair market value of community property generally is included in the decedent’s estate, the surviving spouse’s basis for the entire property in this case becomes 100% of the fair market value.

For example, you and your spouse owned community property that had a basis of $80,000. When your spouse died, half of this interest was included in his estate. The fair market value of the community interest was $100,000. The basis of your half of the property after your spouse’s death is $50,000 (half of the $100,000), and the basis in the other half is $50,000; its original basis does not impact your tax basis in this case.

Property Inherited in 2010

For property inherited from someone who dies in 2010, there is a “modified carryover basis rule” that applies to larger estates. Carryover basis means you step into the shoes of the decedent and take over his or her basis in the assets (generally what the decedent paid for the assets).

The “modified” comes into play because the stepped-up basis rule continues to apply to up to $3 million of assets passing to a surviving spouse, plus $1.3 million to any other heirs. Thus, heirs of estates of up to $4.3 million may continue to enjoy the stepped-up basis rule.

Because of continuing uncertainty about estate tax rules for 2010, the IRS has not yet provided any guidance on the modified carryover basis rule. It’s working on this, and we’ll bring developments to you as soon as they are released.